2013 Feb 26 Presentation to the Standing Committee on Alberta’s Economic Future on the Study of BRIK (Bitumen Royalty-in-Kind) Program

Speaking Notes

Gil McGowan, President

As elected officials from across the province, you all know that the majority of Albertans want to see more upgrading done within our borders.

You’ve seen the polls. And you’ve heard directly from your constituents.

In their hearts and in their guts, Albertans feel a strong need to move up the value ladder.

Albertans are saying “yes” to adding value and “no” to sending high-quality, high-paying jobs down the pipeline to places like the US Midwest, the US Gulf Coast and, in the future, to China.

The wishes and preferences of Albertans on this issue are clear.

But, we all know that public opinion isn’t enough. In order to become a reality, upgrading also has to pass the economic test.

On that score, the power players in the oil industry are on entirely different page than ordinary Albertans.

They say the numbers don’t add up for Alberta-based upgrading.

They put on their longest faces and sadly report that we have no choice but to get comfortable on the lowest rung of the value ladder.

They say that the case is closed.

But we at the AFL aren’t buying it.

I’m here today to challenge the industry’s conventional wisdom.

I’m here to say that the industry power players are wrong…and that the majority of supposedly ill-informed ordinary Albertans are right.

I’m also here to thank Premier Redford…but also to take her to task.

Albertans should thank her for drawing wide public attention to the whole concept of the differential between the price that’s paid for conventional oil and the price we get for bitumen.

The premier is right when she says that the differential is incredibly important to the future of the Alberta economy.

But she’s dead wrong when she says that a widening differential is a disaster for our province. The truth is that a wider differential dramatically improves the economics of upgrading and presents us with an opportunity to do exactly what they majority of Albertans want us to do – and that is, move up the value ladder.

To put it another way, the so-called bitumen bubble that has been inflated by the widening differential has a very significant silver lining. And if the goal of this committee and this government is to develop effective public policy, it’s a silver lining that cannot be over-looked or ignored.

For those of us in Alberta’s labour movement, the need for our policy makers to see and seize the opportunity presented by the widening differential is great. The need for policy leadership is great because, as a province, we are in the process of tumbling down the value ladder, rather than climbing up it.

This slide shows the reality we’re facing today. Throughout the 80s, 90s and well into this decade, we normally upgraded about two-thirds of our raw bitumen to synthetic crude. Former Premier Stelmach promised that his government would ensure that 70 per cent would be upgraded within the province. That’s why he established the BRIK program. But we’re moving in the wrong direction. Today, we upgrade only 58 per cent and the ERCB projects that by 2017, that figure will drop to 47 per cent.

Even worse, a report prepared last for the government by the consulting firm Wood MacKenzie projects that by 2025 Alberta will be upgrading only 26 per cent of our bitumen.

To be clear, no one is talking about shutting down existing upgrading or refining facilities. They’re all very, very profitable. In fact, there isn’t an upgrader or refinery in the country that isn’t making money hand over fist. Instead, the problem is that – with the notable exemption of the Northwest Upgrader and refinery – no new upgrading capacity is being added in our province. Virtually all of our province’s new oil sands production is going to be shipped out of the province in raw form.

Why is this a problem? It’s a problem because by shipping our bitumen raw, we’re letting literally thousands and thousands of good jobs slip through our fingers.

A single upgrader employs up to 2,000 people in direct operations positions. It also provides millions of man-hours of employment each year for construction workers doing regular maintenance and turnarounds.

In addition, as the Conference Board of Canada has pointed out, upgraders and refineries have incredibly long supply chains – so the spin-off affects to suppliers and local businesses are huge.

And these are temporary, transitory jobs in construction. These are long-term, stable, family-sustaining, community-building jobs. If you don’t build the upgraders and refineries, you don’t get these jobs – it’s as simple as that.

Our federation, working with the Communications, Energy and Paperworkers Union, has estimated that if the volume of diluted bitumen slated to go down the Keystone XL pipeline were instead upgraded in Alberta before being exported as synthetic crude, it would create as many as 18,000 permanent, direct and indirect jobs.

If the bitumen slated for the Northern Gateway pipeline was upgraded here and shipped as synthetic crude, it would create 26,000 jobs.

Those are numbers provided by economists working for the labour movement. But for our purposes today, I want to draw your attention to work done by other economists…in particular, work done by economists and energy experts working for the Alberta government itself.

We at the AFL do a lot of FOIP searches…and we recently did a search on reports conducted or commissioned by the government on the subject of upgrading.

The search netted about 8,000 pages of documents. But there were two that really stood out, both of which we have included in your kits.

The first is entitled “Alberta’s Value Added Oil Sands Opportunities and Bitumen Royalty in Kind.”

It includes this slide, which shows that when you export bitumen in raw or diluted form, you capture about 35 per cent of the value chain. But if you upgrade that same bitumen to synthetic crude and export that product, you capture 70 per cent of the value chain. And if you move even higher up the chain, to products like gasoline, diesel, jet fuel and petrochemicals, you can essentially capture 100 per cent of the value chain.

At the same time there is compelling evidence that moving up the value ladder will also generate more revenue for government to help pay for things that Albertans need like health care or education or which can be saved for future generations.

For example, just a few months ago, Ian McGregor from Northwest Upgrading told this committee that if his very small refinery had been in operation last year, it would have generated approximately $500 million more in revenue for the government than they got by allowing the bitumen to be exported raw. And that’s on a volume of 37,500 barrels per day…which is tiny compared to overall production from the oil sands.

So that’s what we stand to lose if we don’t find a way to arrest our province’s headlong tumble down the value ladder. Thousands of jobs. Millions, perhaps billions, in public revenue. And the difference between 35 per cent of the value chain and 70 per cent.

Of course, the skeptics will say – and have said – that the numbers just don’t add up.

And for a few years – just a few (between 2009 and 2011) – they didn’t. But they do now.

To illustrate my point, I’d like to draw your attention to the second very important document that we received as a result of our FOIP search.

This one is entitled “Oil Sands Fiscal Regime Competitiveness Review.” It comes to a number of very interesting conclusions about royalties (it shows we are not getting a fair share for the sale of our collectively owned resources) and carbon taxes (it shows that there is little to be feared from a carbon tax and actually something to be gained).

But for our purposes, I want to focus on the report’s findings on upgrading.

Basically, it says that there were two factors undermining the economics of Alberta-based upgrading between 2009-2011. The first was the spike in the cost of the oil sands related construction and the second was the narrowing of the differential between world oil prices and the price for bitumen.

Like many, many other studies I’ve seen this one concluded that the high cost of construction was a direct result of the pace of development. Too many projects, approved and under construction at the same time were undermining productivity and driving up costs.

On the differential side, the study points out that, contrary to the arguments presented and repeated recently by the premier, that a relatively wide differential is nothing new and nothing to be afraid of. In fact, the study shows that the differential has hovered in the 25-30 per cent range for most of the past two decades.

The study also shows that wider spread between conventional and oil prices and bitumen prices is not only good for Alberta-based upgrading, it’s our biggest competitive advantage.

Take a look at this slide. What it shows are the break even points for SAGD, mining and integrated projects at different differential and price levels. Look closely. What it shows is that projects with upgraders are very economic unless the differential gets narrower than 15 per cent. On the other hand, the viability of SAGD operations without upgraders plummets as the differential gets wider.

The picture is similar in the next slide, also from the same report. What this one shows is that upgraders are entirely viable in the current price and differential climate.

Here’s the report’s conclusion:

“Despite the fact that adding upgrading capacity makes less economic sense in today’s market (2011, when the differential was 15 percent), our sensitivity analysis suggests an integrated upgrader serves as a hedge against volatility of the light-heavy differential.”

Did you hear that? Upgraders profitable when the differential is above 25 per cent AND they are a responsible hedge against volatility in the light-heavy differential. They’re profitable over a greater range of market scenarios than extraction-only projects.

All this talk about differentials and sensitivity analysis sound confusing. But it’s actually really simple. Low bitumen prices are actually good for us because they allow our upgrader to buy their feedstock low and sell their refined products high. In fact SCO often trades at a premium to WTI priced conventional oil.

So that’s our question for the government as the steward of our collectively-owned resources: why shouldn’t we buy low and sell high? Why sell the world products that fetch a higher price and keep the jobs for ourselves?

That leads me to our recommendations:

First, we need to see the widening differential not as a threat, but as an opportunity.

Second, we need to stop chasing the mirage of price parity between bitumen and conventional oil. The differential is not the result of lack of market access. It the natural result of bitumen’s lower quality.

Do you remember the old Russian Ladas? The fact that they couldn’t get the same price for one of those hunks of junk as GM could get for a Cadillac was because they lacked market access. It was because their product was junk. We face a similar problem with bitumen. It may not be junk, but it’s not conventional oil. So instead of chasing the impossible dream of getting world price for our sub-par product, let’s upgrade and sell that higher-value product. The only way to get Cadillac prices is to sell a Cadillac product.

Third, we need to set a more reasonable pace for development in the oil sands. Unrestrained pace is driving up costs and higher costs are one of the factors leading companies to opt for the cheaper, extraction-only projects. But failing to set a more reasonable pace of development, as Peter Lougheed suggested, we’re pricing ourselves out of the market for the kind of value-added projects that Albertans want and which would be better for our economy over the long term.

Fourth, we need to make upgrading a condition of development, not an option. By leaving these important decisions entirely in the hands of largely foreign-based multi-national energy corporations, we’re ignoring Lougheed’s advice to act like owners. Even now that the numbers do add up for Alberta-based upgrading, these companies are not investing in value-added projects because have their own, existing refining plants in the US or in China. They see the money that can be made by buying our bitumen low and shelling the refined product high. But it’s our resource and it is we, the citizens of Alberta, who should be seizing the value opportunity, not some foreign based energy giant. It may make all sorts of sense from a private-profit point-of-view for Exxon and Sinopec to rip and ship our raw resources. But just because it makes sense for them, doesn’t mean it makes sense for Albertans, who own the resource.

Fifth, we need to expand the Bitumen Royalty In Kind program. It’s a good program, but we can’t build our provinces energy program with just one BRIK.

Finally, we need to be bold and build on Peter Lougheed’s legacy. Energy companies like Exxon and Sinopec cannot be counted on to make development decisions that are in the best interests of Albertans who own our resources. The approach that Lougheed took to build our petrochemical industry is actually the one we should take today with bitumen. He set a clear goal of building a value-added industry. He understood that the government, as the steward of the resources, had to be a participant in the market, not just a spectator. He introduced regulations about what could be exported and couldn’t be. He used public money to build critical infrastructure like straddle plans to support a value-added industry. And he created a public energy corporation to enter into joint-venture projects with reluctant private-sector investors. And it worked.

In the end, all we’re asking the government to do is to see and seize the opportunity that’s in front of us.

And we’re not asking you to do anything that previous Progressive Conservative governments haven’t already done. We are asking you to lead like Lougheed.